Deck 12: Investment and Financial Markets

Question 1

The term investment refers, in general, to

A) only large projects, such as building a new factory, undertaken by private firms.
B) only the creation of capital goods undertaken by private firms or the government.
C) any action today that has costs today but provides expected benefits in the future.
D) any action today that has costs today.

Answer 1

any action today that has costs today but provides expected benefits in the future.

Question 2

Procyclical variables ________ during expansions and ________ during recessions.

A) fall; fall
B) rise; rise
C) fall; rise
D) rise; fall

Answer 2

rise; fall

Question 3

Keynes referred to the sharp, often irrational, changes in the outlook of investors as the ________ of investors.

A) animal spirits
B) primal needs
C) chaotic behavior
D) crowd psychology

Answer 3

animal spirits

Question 4

What is most affected by the expected rate or pace of economic growth?

A) unemployment
B) investment spending
C) government purchases
D) exports

Question 5

Investment spending tends to be

A) procyclical.
B) anticyclical.
C) unrelated to GDP.
D) a periodic variable.

Question 6

The multiplier-accelerator model was developed by

A) John Maynard Keynes.
B) Paul Samuelson.
C) classical economists.
D) Walter Heller.

Question 7

Accelerator theory refers to the theory of

A) investment that emphasizes that current investment spending depends positively on the expected future growth of government spending.
B) investment that emphasizes that current investment spending depends positively on the expected future growth of GDP.
C) consumption that emphasizes that current consumer spending depends positively on the expected future growth of GDP.
D) consumption that emphasizes that increases in consumption spending will result, through the multiplier effect, in greater increases in GDP.

Question 8

Ceteris paribus, as real GDP expected growth ________, investment spending ________.

A) increases; decreases
B) increases; increases
C) decreases; increases
D) changes; does not usually change

Question 9

If firms receive an economic forecast predicting future increases in the growth of real GDP, they are likely to respond by

A) decreasing their level of investment spending to decrease future production capacity.
B) increasing their level of investment spending to increase current production capacity.
C) increasing their level of investment spending to increase future production capacity.
D) decreasing their level of investment spending to decrease current production capacity.

Question 10

When investors reduce their investment spending, it is a sign that they are ________ about the economy.

A) optimistic
B) pessimistic
C) ill-advised
D) taking risks

Question 11

Recall the Application about energy price uncertainty and its impact on investment spending and GDP growth to answer the following question(s). Increases in oil prices can lead to a drop in GDP. However, uncertainty about oil prices is also an important factor. The volatility of oil prices creates uncertainty for firms making investment decisions, and adversely affects GDP growth.
This application addresses the idea that

A) financial intermediaries facilitate investment spending.
B) government spending is needed to pull an economy out of a recession.
C) investment spending is the least stable component of GDP.
D) consumer spending is the most stable component of GDP.

Question 12

The theory of investment that emphasizes the role of expected growth in real GDP on investment spending is known as

A) real business cycle theory.
B) the theory of animal spirits.
C) the accelerator theory.
D) the multiplier theory.

Question 13

From the beginning of the 1990s to the year 2000, investment spending as a share of U.S. GDP has tended to

A) increase.
B) decrease.
C) remain the same.
D) fluctuate wildly.

Question 14

Optimistic investors tend to ________ their investment spending.

A) reduce
B) increase
C) defer
D) not change

Question 15

Recall the Application about energy price uncertainty and its impact on investment spending and GDP growth to answer the following question(s). Increases in oil prices can lead to a drop in GDP. However, uncertainty about oil prices is also an important factor. The volatility of oil prices creates uncertainty for firms making investment decisions, and adversely affects GDP growth.
According to this Application, the volatility of energy prices can contribute to uncertainty in the economy. An increasingly uncertain future will tend to cause firms to

A) delay their investment decisions.
B) wait for significant GDP growth before reducing investments.
C) rely on the government to make their investment decisions for them.
D) continue with a stable flow of investment spending so as not to get trapped by a downturning economy.

Question 16

Which of the following is an example of an investment, as described in Chapter 12 of your textbook?

A) A firm builds a new plant.
B) A student attends college.
C) The government builds a dam to have a source of hydroelectric power.
D) all of the above

Question 17

If firms receive an economic forecast predicting future decreases in the growth of real GDP, they are likely to respond by

A) decreasing their level of investment spending to decrease future production capacity.
B) increasing their level of investment spending to increase current production capacity.
C) increasing their level of investment spending to increase future production capacity.
D) decreasing their level of investment spending to decrease current production capacity.

Question 18

The payoffs resulting from new investment

A) occur in the future and are known with certainty.
B) occur in the present and are known with certainty.
C) occur in the future but are not known with certainty.
D) depend only on current profits.

Question 19

The multiplier-accelerator model

A) suggests that a downturn in real GDP will lead to a sharp fall in investment, which leads to further reductions in GDP through the multiplier.
B) links investment spending to stock prices.
C) emphasizes that current investment spending depends negatively on the expected future growth of GDP.
D) emphasizes the role of real interest rates and taxes.

Question 20

Compared to consumption, investment is a much ________ component of GDP and is much more ________.

A) larger; stable
B) smaller; stable
C) larger; volatile
D) smaller; volatile

Question 21

If interest rates increase, the present value of a given payment in the future will

A) remain the same.
B) increase.
C) decrease.
D) cause an inflation.

Question 22

What is the accelerator theory of investment spending?

Question 23

When individuals or firms make an investment, they incur costs today in the hope of future gains.

Question 24

If you want to purchase a new sports car in four years for $75,000, how much would you need to have in your bank account now, so after four years you will have $75,000 to buy the car? Assume your bank pays 6 percent interest.

A) $51,226
B) $59,408
C) $60,484
D) $70,755

Question 25

At an interest rate of 4 percent, what would be the present value of receiving $4,000 four years from now?

A) $3,420
B) $3,637
C) $3,704
D) $3,847

Question 26

Suppose that a firm can invest $100 today in a project and receive $105 a year from today. There is no inflation, and the annual interest rate in the economy is 4%. The firm should

A) invest in the project because the opportunity cost is less than the return on the investment.
B) invest in the project because the opportunity cost is greater than the return on the investment.
C) invest in the project because the opportunity cost is the same as the return on the investment.
D) not invest in the project because the opportunity cost is less than the return on the investment.

Question 27

Investments are actions that incur costs in the future but provide expected benefits today.

Question 28

Investment, a key component of aggregate demand, can cause recessions and booms based on fluctuations in its levels.

Question 29

Investment spending tends to be closely related to the current pace of economic growth.

Question 30

Investment is a smaller component of GDP than consumption, but it is a more stable component.

Question 31

Why does investment spending rise and fall with the overall level of GDP in the economy?

Question 32

The present value of a payment K that is schedule to be received t periods from now is

A) K / (1 + i)t.
B) K - i / (1 + i)t.
C) K / (1 - i)k.
D) K / (K + i)t.

Question 33

The maximum amount a person is willing to pay today to receive a payment in the future is known as

A) nominal interest.
B) present value.
C) real interest.
D) retained earnings.

Question 34

Suppose that a firm can invest $100 today in a project and receive $105 a year from today. There is no inflation, and the annual interest rate in the economy is 6%. The firm should

A) invest in the project because the opportunity cost is less than the return on the investment.
B) invest in the project because the opportunity cost is greater than the return on the investment.
C) invest in the project because the opportunity cost is the same as the return on the investment.
D) not invest in the project because the opportunity cost is greater than the return on the investment.

Question 35

Investment spending is countercyclical.

Question 36

Recall the Application about energy price uncertainty and its impact on investment spending and GDP growth to answer the following question(s). Increases in oil prices can lead to a drop in GDP. However, uncertainty about oil prices is also an important factor. The volatility of oil prices creates uncertainty for firms making investment decisions, and adversely affects GDP growth.
According to this Application, if the volatility of energy prices led to expectations of declining real GDP, investment spending at that time would tend to decrease. This relationship between the decrease in investment spending and the expected decline in real GDP would be expressed by the

A) liquidity principle.
B) accelerator theory.
C) present value theory.
D) real-nominal principle.

Question 37

If you want to purchase a new sailboat in two years for $9,000, how much would you presently need to have in your bank account to have $9,000 in two years? Assume your bank account pays 3 percent interest.

A) $8,484
B) $8,613
C) $8,738
D) $8,822

Question 38

What is a broad definition for an investment?

Question 39

The present value of a given payment in the future ________ when the interest rates fall.

A) increases
B) decreases
C) remains the same
D) reverts to the original value

Question 40

The opportunity cost of something is

A) what you sacrifice to get it.
B) the price you must pay to purchase it.
C) the real rate of interest.
D) what you get when you give something up.

Question 41

At an interest rate of 6 percent, what would be the present value of receiving $22,000 twelve years from now?

A) $10,934
B) $18,645
C) $19,643
D) $20,755

Question 42

Recall the Application about opting for a lump sum of $500,000 for your retirement or $35,000 per year for the rest of your life to answer the following question(s).
Assume the retiree had a third option: receive a lump sum of $750,000 five years from now. If the interest rate is 4 percent, approximately how much is the future $750,000 to be received in 5 years worth today?

A) $586,445
B) $616,445
C) $630,000
D) $646,555

Question 43

Scenario 12.1: Jennifer has decided to give up her pack-a-day smoking habit and invest the money she would have spent on cigarettes in a retirement account. At $6.00 a pack, Jennifer is currently spending $2,190 per year on cigarettes. Jennifer is 25 years old and plans to retire in 35 years, at age 60. She has chosen a retirement account that will earn a long-term average return of 5 percent per year. Jennifer is currently earning $40,000 annually. Assume that the average annual inflation rate will be 5 percent per year, that the cost of cigarettes will increase with inflation, and that Jennifer's income will also rise with the inflation rate.
Refer to Scenario 12.1 At the assumed annual inflation rate of 5 percent, approximately how much will the $6.00 pack of cigarettes cost in 10 years, when Jennifer reaches the age of 35?

A) $8
B) $10
C) $16
D) $23

Question 44

Recall the Application about opting for a lump sum of $500,000 for your retirement or $35,000 per year for the rest of your life to answer the following question(s).
This Application addresses the economic concept of

A) procyclical investment.
B) the multiplier-accelerator model.
C) financial intermediaries.
D) present value.

Question 45

Recall the Application about opting for a lump sum of $500,000 for your retirement or $35,000 per year for the rest of your life to answer the following question(s).
If the interest rate is 4 percent, how much interest would the retiree earn the first year if she opted for the lump sum payment, and chose to invest the entire payment at this interest rate?

A) $1,400
B) $20,000
C) $55,000
D) $235,000

Question 46

Suppose you have $400 to invest at a nominal interest rate of 7 percent, and the investment's term to maturity is 1 year. If the inflation rate is 2 percent, then the real return on your investment is approximately

A) $8.
B) $20.
C) $28.
D) $36.

Question 47

If the nominal interest rate is 2 percent and the inflation rate is 4 percent, then the real rate of interest is

A) -2 percent.
B) 2 percent.
C) 3 percent.
D) 6 percent.

Question 48

If the nominal interest rate is 4 percent and the inflation rate is 1 percent, then the real rate of interest is

A) 1 percent.
B) 3 percent.
C) 4 percent.
D) 5 percent.

Question 49

Nominal interest rates are the

A) interest rates quoted in the market minus the inflation rate.
B) interest rates quoted in the market plus the expected inflation rate.
C) interest rates quoted in the market.
D) real interest rates less the inflation rate.

Question 50

The real-nominal principle can be stated as

A) production generates income.
B) only final goods and services should be counted in GDP.
C) what matters to people is the purchasing power of money or income.
D) only the manufacture of real goods is production.

Question 51

Scenario 12.1: Jennifer has decided to give up her pack-a-day smoking habit and invest the money she would have spent on cigarettes in a retirement account. At $6.00 a pack, Jennifer is currently spending $2,190 per year on cigarettes. Jennifer is 25 years old and plans to retire in 35 years, at age 60. She has chosen a retirement account that will earn a long-term average return of 5 percent per year. Jennifer is currently earning $40,000 annually. Assume that the average annual inflation rate will be 5 percent per year, that the cost of cigarettes will increase with inflation, and that Jennifer's income will also rise with the inflation rate.
Refer to Scenario 12.1. Assume Jennifer gave up smoking for only one year and invested that money ($2,190)at the 5 percent interest rate. How much would the investment be worth in 35 years?

A) $2,300
B) $12,080
C) $32,445
D) $80,483

Question 52

If the real interest rate is 4 percent and the inflation rate is 3 percent, then the nominal interest rate is

A) -1 percent.
B) 1 percent.
C) 3.5 percent.
D) 7 percent.

Question 53

Scenario 12.1: Jennifer has decided to give up her pack-a-day smoking habit and invest the money she would have spent on cigarettes in a retirement account. At $6.00 a pack, Jennifer is currently spending $2,190 per year on cigarettes. Jennifer is 25 years old and plans to retire in 35 years, at age 60. She has chosen a retirement account that will earn a long-term average return of 5 percent per year. Jennifer is currently earning $40,000 annually. Assume that the average annual inflation rate will be 5 percent per year, that the cost of cigarettes will increase with inflation, and that Jennifer's income will also rise with the inflation rate.
This Scenario addresses the economic concept of

A) deposit insurance.
B) present value.
C) financial intermediaries.
D) retained earnings.

Question 54

Real interest rates are the

A) interest rates quoted in the market minus the inflation rate.
B) interest rates quoted in the market plus the expected inflation rate.
C) interest rates quoted in the market.
D) nominal interest rates plus the inflation rate.

Question 55

If the real interest rate is 4 percent and the nominal interest rate is 7 percent, this implies an expected inflation rate of

A) 3 percent.
B) 4 percent.
C) 5.5 percent.
D) 11 percent.

Question 56

Scenario 12.1: Jennifer has decided to give up her pack-a-day smoking habit and invest the money she would have spent on cigarettes in a retirement account. At $6.00 a pack, Jennifer is currently spending $2,190 per year on cigarettes. Jennifer is 25 years old and plans to retire in 35 years, at age 60. She has chosen a retirement account that will earn a long-term average return of 5 percent per year. Jennifer is currently earning $40,000 annually. Assume that the average annual inflation rate will be 5 percent per year, that the cost of cigarettes will increase with inflation, and that Jennifer's income will also rise with the inflation rate.
Refer to Scenario 12.1. By what approximate percentage will Jennifer's income increase from age 25 to age 60?

A) 287 percent
B) 400 percent
C) 452 percent
D) 561 percent

Question 57

Which of the following equations is correct?

A) real interest rate = nominal interest rate - inflation
B) real interest rate = nominal interest rate + inflation
C) nominal interest rate = real interest rate - inflation
D) real interest rate = nominal interest rate * inflation

Question 58

Scenario 12.1: Jennifer has decided to give up her pack-a-day smoking habit and invest the money she would have spent on cigarettes in a retirement account. At $6.00 a pack, Jennifer is currently spending $2,190 per year on cigarettes. Jennifer is 25 years old and plans to retire in 35 years, at age 60. She has chosen a retirement account that will earn a long-term average return of 5 percent per year. Jennifer is currently earning $40,000 annually. Assume that the average annual inflation rate will be 5 percent per year, that the cost of cigarettes will increase with inflation, and that Jennifer's income will also rise with the inflation rate.
Refer to Scenario 12.1 At the assumed annual inflation rate of 5 percent, approximately how much will the $6.00 pack of cigarettes cost in 30 years, when Jennifer reaches the retirement age of 60?

A) $16
B) $21
C) $33
D) $47

Question 59

If the real interest rate is 5 percent and the nominal interest rate is 2 percent, this implies an expected inflation rate of

A) -7 percent.
B) -3 percent.
C) 3.5 percent.
D) 7 percent.

Question 60

If the real interest rate is 7 percent and the inflation rate is 7 percent, then the nominal interest rate is

A) 0 percent.
B) 3.5 percent.
C) 7 percent.
D) 14 percent.

Question 61

Expected real interest rates are the

A) interest rates quoted in the market minus the expected inflation rate.
B) interest rates quoted in the market plus the expected inflation rate.
C) expectations of future interest rates.
D) interest rates quoted in the market.

Question 62

Suppose you have $400 and the inflation rate is 4 percent. In order to earn a real return of $20 on your investment, the nominal interest rate must be

A) 1 percent.
B) 5 percent.
C) 9 percent.
D) 12 percent.

Question 63

If inflation is eight percent, a nominal interest rate of six percent translates into a real interest rate of two percent.

Question 64

Borrowers and lenders make transactions based on the

A) real interest rate.
B) expected real interest rate.
C) expected nominal interest rate.
D) expected real interest rate less the expected rate of inflation.

Question 65

Table 12.1
Expected Real Rates of Interest for Five Countries

Source: Trading Economics, September, 2010
Refer to Table 12.1. Assuming the inflation rate forecast to be accurate, which nation has the lowest real rate of return?

A) Japan
B) Australia
C) South Africa
D) the United States

Question 66

Both the nominal rate of interest and the real return on investment increase with the inflation rate.

Question 67

If you want to have $50,000 in 5 years, how much would you need to put in your savings account now if the savings account pays 3 percent interest?

Question 68

Suppose you have $400 to invest at a nominal interest rate of 5 percent. If the inflation rate is 2 percent, then the real return on your investment is approximately

A) $12.
B) $20.
C) $28.
D) $36.

Question 69

Table 12.1
Expected Real Rates of Interest for Five Countries

Source: Trading Economics, September, 2010
Refer to Table 12.1. The inflation rate forecast for Japan is

A) -0.9%.
B) 0.9%.
C) 1.1%.
D) cannot be determined from the information provided.

Question 70

The real interest rate is the rate at which borrowers or lenders ________ to make transactions when issuing or receiving loans.

A) are required
B) expect
C) refuse
D) can only obtain from a financial intermediary

Question 71

When the nominal rate of interest and the rate of inflation are the same, the real interest rate is zero.

Question 72

Table 12.1
Expected Real Rates of Interest for Five Countries

Source: Trading Economics, September, 2010
Refer to Table 12.1. Assuming the inflation rate forecast to be accurate, which nation would pay the highest nominal rate of return?

A) South Africa
B) Australia
C) Brazil
D) the United States

Question 73

Table 12.1
Expected Real Rates of Interest for Five Countries

Source: Trading Economics, September, 2010
Refer to Table 12.1. The nominal interest rate for the United States is

A) -0.25%.
B) 0.25%.
C) 2.15%.
D) cannot be determined from the information provided.

Question 74

The opportunity cost of funds is the interest that can be earned by lending the funds.

Question 75

Suppose you have $400 and the inflation rate is 5 percent. In order to earn a real return of $16 on your investment, the nominal interest rate needs to be near

A) 0 percent.
B) 4 percent.
C) 6 percent.
D) 9 percent.

Question 76

The rate of interest that a bank states as its interest rate is the real rate of interest.

Question 77

Table 12.1
Expected Real Rates of Interest for Five Countries

Source: Trading Economics, September, 2010
Refer to Table 12.1. The expected real rate of interest for Australia is

A) -1.4%.
B) 1.4%.
C) 6.9%.
D) cannot be determined from the information provided.

Question 78

As real rates of interest increase in the economy, real investment spending increases.

Question 79

If a project costs $600 today and returns $630 next year, the highest interest rate at which the project should still be undertaken is five percent.

Question 80

It is difficult to determine expected real rates of interest because

A) we cannot measure the inflation rate.
B) we cannot measure the nominal interest rate.
C) the inflation rate is a subjective measurement.
D) we never know exactly what inflation rates people anticipate.